Pound jumps on shock rebound in core inflation

THE POUND hit a seven-week high against the dollar yesterday as investors reacted to a higher-than-expected inflation figure.

Official data showed the consumer price index (CPI) – which gauges the price of a typical basket of goods and services – rose 0.1 per cent in the year to July, from zero a month earlier. While it narrowly beat most economists’ expectations, the big surprise was a jump in core inflation, which removes more volatile sectors, such as energy, food and tobacco, from the CPI basket.

Core inflation hit a five-month high, rising from 0.8 per cent to 1.2 per cent in July.

The rise in the value of the pound shows markets betting that interest rates are likely to be hiked earlier by the Bank of England’s monetary policy committee (MPC) than previously expected.

“Waiting too long would risk undermining the recovery – especially if interest rates then need to be increased faster than the gradual path which we expect,” Forbes wrote in the Telegraph.

Forbes’ comments on the long-term outlook for rates combined with yesterday’s core inflation rise have generated more uncertainty over the timing of the first hike.

“The MPC is focused on the outlook for inflation at the two-three-year horizon. From this perspective, the jump in core inflation is more noteworthy than the smaller surprise to the headline measure driven by short-term factors. This should keep the policy debate lively now that the vote is split,” said economist Sam Hill from RBC Capital Markets.

The Bank of England has outlined what it believes are temporary factors dragging down inflation. One is a collapse in oil prices, second is the strength of the pound, which makes imports cheaper, and third is a more recent fall in other commodity prices such as gold and copper. These weigh heavily on inflation, but much less so on core inflation.

The Bank expects these to begin wearing off towards the end of the year. Some economists said it boosts the case for raising rates sooner.

“It is important that a low headline rate of inflation does not stand in the way of normalising interest rates,” said economist James Sproule from the Institute of Directors.

Other economists doubted the rise in the core figure and said it was due to a mismatch in the timing of summer clothing sales this year and in 2014.